As a financial coach, I focus on how behaviors and mentalities affect my clients’ results. I also sometimes consider how public policy affects these results as well. Sometimes I have to say something about how legislators’ actions affect what we can and cannot do. Social Security is just one of those programs that irks me to the core.
Social Security is one of the most socially ingrained government programs in America today. Since President Franklin Roosevelt signed the program into law in 1935, it’s been there to provide senior citizens supplementary income in their golden years. The program also has disability and survivor benefits added onto it.
Social Security’s Original Setup
Initially, this appeared to work just fine, especially when the worker-to-retiree ratio was 159 to 1. But that ratio is now at just three-to-one. The estimates put Social Security at insolvency as early as 2035, right around its 100th birthday.
I could go on about the philosophy of this program and the merits from a political standpoint. But that’s not my objective here. Rather, I want to look at this from a financial coach’s perspective. I want to show how this program has not been benefiting Americans the way the politicians claim.
The math behind Social Security is absolutely abysmal, to put it lightly. The program itself fiscally unsustainable. But it hardly gives any sort of true return for people who plan to rely on it for retirement income.
Once you get past the pundits’ partisan pandering, here is what Social Security is actually doing for (to) Americans.
The Opportunity Cost of Social Security
The median household income in the United States, as of 2018, is approximately $62,000. The Social Security tax is 12.4%, half from the employer, half from the employee (but the entire 12.4% for self-employed folks). That equals about $7,700 per year.
The current annual contribution limit (as of 2021) for IRAs is $6,000 ($7,000 for those over age 50). The payroll taxes take more from the average worker than he or she could put into a tax-advantaged account. And all for what, living at the poverty line on monthly benefits?
What Would An Alternative Be?
Imagine if, instead of federal bureaucrats taking 12.4% of your income, you put that $7,700 into an IRA. That’s about $640 a month. And let’s do that over a working lifetime, from age 25 to age 65. Let’s say you invest into good funds that average about a 10% rate of return. This is a very reasonable expectation.
Let’s also say this hypothetical person even remains at an average of $62,000 for his or her entire life. By putting what would have been Social Security tax into that IRA, that’s a total of $308,000 in contributions.
But, with 10% annual growth, that $308,000 will have grown into $3.39 million. Even if the rate of return is only 6%, that’s still $1.18 million at age 65. And if somehow the average annual return was 14%, that $308k would have become a staggering $10.3 million!
This chart shows what that growth would look like over a working lifetime.
On the other hand, consider the average Social Security payouts. In 2019, the average monthly benefit paid to retirees was $1,461 a month, or $17,532. That’s just barely above the federal poverty level of $16,910 for a family of two.
What if you have that $3.39 million in your IRA, and keep it invested getting 10% each year? That’s an average growth of $339,000 each year. Even if you draw 4%, that’s $135,600 per year, or $11,300 a month for monthly expenses.
Could you make it on $3 million? Or $1 million? To me, there is simply no question about where the better deal would be.
I normally don’t like doing math (I know, ironic for a financial coach). But I’ll take math’s side on this issue every day of the week and twice on Sunday.
And all of this doesn’t even address the fiscal trouble that Social Security is in. The program cannot sustain itself at its current rate. I discuss that more here.
Social Security takes a big cut of our earnings and doesn’t give much back. But there are still other opportunities for you to grow your net worth and become financially independent and free.
Schedule your free Discovery Session today to see what your options are and how to put them into action.